Obvious (But Original) Thought About The Gold Stock To Price Of Gold Ratio

The following graph has been commented upon by various Gold stock investing news letter writers, aka pumpers.

The argument is that gold stocks (as represented by the $HUI index) have not been doing as well as the price of gold itself; that previously, gold stocks were substantially higher relative to gold than they are now. With the usual reversion to the mean, this means that gold stocks "should" rise relative to the price of gold going forward. This means they are a better investment, in some sense, than gold itself.

Up until having my original thought, I considered this to be a pretty valid argument.

Just eyeballing the chart we see that a ratio of about .5 is about right for the "previous" mean that the stocks (and gold) "should" be reverting to. The ratio is now about .3. That is, 40% lower than this mean we are discussing.

Now, that's an interesting number. Down 40%. Sounds like the general stock market. Down roughly 40%.

Here's the original thought: Maybe the reason why gold stocks are down 40% relative to the price of gold is because they are stocks and, like all stocks, they were overvalued back in the good old days (2004 to 2007) and have come down accordingly. If that is the case, then you can't really expect gold stocks to revert to that overvalued, "bogus" mean. In fact, relative to gold they may, like all stocks, continue to fall (going forward).

Look at the chart again. They could easily fall to a ratio of .15 (the low from the previous, very mild recession). That would be another 50% loss relative to the price of gold. Now, that's a new thought!

What do you think?

MontyHigh, www.worldofwallstreet.us

Comments

[Alexs_Pushkin]

I think that a 25 year chart show a better picture.
Thanks to Bob Moriarity for the chart:
http://www.321gold.com/editorials/moriarty/moriarty082508.html

[Neil]

I wrote some fairly lengthy thoughts on the weaknesses in your line of argument at:
http://newcdninvestor.blogspot.com/2009/02/gold-stock-to-gold-price-ratio.html

It may be, of course, that I'm just hoping that you're wrong.